Monday, August 8, 2016

A world without cash

What would a government-backed digital currency look like? A country’s central bank would need to become a deposit-taking institution and hold accounts on behalf of citizens and businesses. All of their debits would be tracked on the central bank’s blockchain, a digital ledger resistant to tampering. The central bank would pay interest electronically by adjusting the balances of depositor accounts.

I'm a big fan of the idea of abundant interest-bearing electronic money, and that the Fed or Treasury should provide abundant amounts of it. (Some links below.) Two big reasons: First, we then get to live Milton Friedman's optimal quantity of money. If money pays interest, you can hold as much as you'd like. It's like running a car with all the oil it needs. Second, it is a key to financial stability. If all "money" is backed by the Treasury or Fed, financial crises and runs end. As Max and David say,

Depositors would no longer have to rely on commercial banks to hold their checking accounts, and the government could get out of the risky deposit-insurance business. Commercial banks that wished to keep making loans would raise long-term capital in the debt and equity markets, ending the mismatch between demand deposits and long-term loans that can cause liquidity problems.

However, there are different ways to accomplish this larger goal. Do we all need to have accounts directly at the Fed, and is a blockchain the best way for the Fed to handle transfers?

The point of the blockchain, as I understand it, is to demonstrate the validity of each "dollar" by keeping a complete encrypted record of its creation and each person who held it along the way.

Its archival blockchain links together all previous transfers of a given unit of currency as a method of authentication. The blockchain is known as a “shared ledger” or “distributed ledger,” because it is available to all members of the network, any one of whom can see all previous transactions into or out of other digital wallets

That, and a limited supply to control its value, was the basic idea of bitcoin. But when we are clearing transactions by transferring rights to accounts at the Fed, the validity of the "dollar" is not in question. It's at the Fed. And, the big advantage relative to bitcoin as I see it, the value of the dollar comes from monetary policy and ultimately the government's demand for "dollars" to be paid in taxes, not from a fixed supply as was the case with gold.

The blockchain also appears to clear transactions more quickly and offer some security advantages. The latter are very attractive -- in my personal life I've recently had the questionable pleasure of spending days enjoying 19th century finance of multi-day clearing times, obtaining notarized signatures and medallion guarantees, and sending pieces of paper around. But not yet ironclad -- The same week of the WSJ has a string of articles on the security of Bitcoin following a recent hack.

The biggest stumbling block in my mind is "all members of the network, any one of whom can see all previous transactions into or out of other digital wallets." Per Max and David, this has pluses and minuses:

Tax collection would become much simpler, and tax evasion and money laundering could become prohibitively difficult.

Yet the centralization of banking under this system would also create a Leviathan with the power to monitor and control the personal finances of every citizen in the country. This is one of the chief reasons why many are loath to give up on hard currency. With digital money, the government could view any financial transaction and obtain a flow of information about personal spending that could be used against an individual in a whole host of scenarios.

This really is a big change in how "money" works. Traditional cash has a lovely property, that it has no memory. Its physical properties determine its value in a way independent of its history. It is incredibly efficient, in a Hayek information sense. The economy does not need the memory of every transaction. Blockchains turn this around.

The anonymity of cash makes it enduringly popular -- cash holdings are up, not down in the digital age. The same week of WSJ reading had articles delving into the continuing popularity of cash, and the mechanics of handling it, the ongoing fury over the planeload of cash delivered by the Obama administration to Iran. It's not hard to figure out why both Iranians and Administration needed to send old-fahshioned bills on an unmarked plane, not a wire transfer.

Indeed creating this Leviathan is a danger, to the economy, and to our political freedom. Our government likes to pass aspirational laws that we don't really mean to enforce. Get rid of cash, and allow the government to see every transaction and enforce every law regarding payment of anything, and 11 million immigrants suddenly can't work at all and become penniless. Rigorous enforcement of all transactions would not only stop your kids lemonade stand and babysitting business, it would wipe out most of the employment opportunities for lower-income America. Many businesses would come to a halt.

The natural response is, well, maybe we shouldn't pass laws we don't really mean to enforce. Good luck with that.

More deeply, "flow of information about personal spending that could be used against an individual in a whole host of scenarios" is truly frightening. I don't think there is a political candidate in the whole country who could not be embarrassed with one purchase at some point in their lives. Consider the brouhaha now over "disclosure" of political contributions -- there is a real fear that disclosure is a way of setting up hit lists for the administration to go after its political enemies. Multiply that by a thousand. Dissenters could easily be silenced if the government can monitor or block every transaction.

The ability to transact with anonymity and privacy has been a central freedom for hundreds of years. It's largely gone already. Losing it entirely and giving the government huge power to enforce any law it passes is not necessarily a good thing.

Mike and David opine

creating and respecting privacy firewalls and rethinking legal-tender laws could mitigate the dangers of monopoly and stifled competition in currency markets.

[Subject-free sentences (creating?) are always a sign of trouble!] The dangers are not of monopoly and competition, the dangers are in the vast loss of privacy that the government, and its leakers and hackers knowing all our transactions implies.

(Here I'm out on a limb on my blockchain knowledge, but I gather that one does have to wipe the slate clean occasionally. Otherwise, the blockchain gets ridiculously long. Imagine each dollar, a hundred years from now, attached to a list of everyone who has ever held it! That wiping out process could do a lot for privacy.)

So, back to basics. It is not at all clear to me in their analysis why the Fed has to manage all the accounts. The Fed, Treasury, and the government in general are very good at defining the units of a currency, and providing an easy standard of value -- cash, coins, liquid government debt, reserves. That is their natural monopoly. I don't see that the government has a similar natural advantage in providing low-cost transactions services, especially on monitoring fraud in the use of those services. The Fed got hacked by employees of the central bank of Bangladesh.

So I leave with two big questions -- and these are questions, and this is an invitation to more thought.

Is a blockchain really better than accounts at the Fed, and instructions to flip a switch to send money from my account to your account? What is the best way to get low transactions costs and fraud prevention, given that we don't need authentication of the dollar itself and a supply limitation?

Is it really better for the Fed to handle all transactions directly, rather than for the Fed to provide clearing accounts, and "banks" (narrow!) to provide transactions services between people, using reserves as now for netting and clearing? The latter setup allows competition and innovation in transactions services, and a better hope for an information firewall retaining some privacy and anonymity in transactions.

26 comments:

I agree that something along the lines of “everyone has an account at the Fed” is desirable in that it means government can get out of the moral hazard infested deposit insurance business. But I have one querie.

You say, “I'm a big fan of the idea of abundant interest-bearing electronic money..”. I’m baffled as to why, just because someone wants to keep $10k under a metaphorical mattress, someone else is obliged to pay taxes so as to fund that interest.

John believes in the risk free return either funded by taxpayers or printed into thin air by the central bank. (He is not clear on which). I don't believe in either.

The interesting part of John's article is this:

"With digital money, the government could view any financial transaction and obtain a flow of information about personal spending that could be used against an individual in a whole host of scenarios."

"This really is a big change in how money works. Traditional cash has a lovely property, that it has no memory."

And yet most people these days deal from checking and savings accounts that have memories. The U. S. Treasury used to sell bearer bonds, but now all issues are sold with a C.U.S.I.P. (Committee on Uniform Security Identification Procedures) identification.

And so let me be the first to say that I don't see the loveliness.

Continuing on:

"Its physical properties determine its value in a way independent of its history."

It's physical properties (lightweight, uniformity of manufacturer, durability, etc.) make it ideal for transactions, but I wouldn't say that alone determines the value of a currency.

And finally:

"It is incredibly efficient, in a Hayek information sense. The economy does not need the memory of every transaction. Blockchains turn this around."

Is improved data collection by the BEA and BLS worth the liberties given up?

http://www.bea.gov/about/infoqual.htm

"Source Data: BEA receives data from a variety of reliable sources. Most of the data, however, come from over 360 surveys and other data collections sponsored by other Federal agencies, that is, from statistical agencies, aggregate tax data sources, administrative and regulatory sources, and private trade sources."

Why conduct surveys when the BEA could simply look at the transaction history of each individual?

I think eliminating cash is a very bad idea. We have already lost a lot of privacy due to terrorist threats. I do not want the government or faceless others tracking every penny I spend and being, ultimately, to control MY money. Nope. Bad, bad idea.

I have a question, what of the possibility of achieving the necessary capabilities of a cashless society, without it being facilitated by a government body. I look to Bob Kocher's recent WSJ article referring to the success of independent physician led accountable-care organizations over their, larger, consolidated and highly respected counterparts. Can we see a path for the private markets to achieve these goals?

"If all "money" is backed by the Treasury or Fed, financial crises and runs end."

That's overly optimistic. There are two ingredients to a bank run:1) an insolvent bank2) a bank that tries to maintain convertibility of its money at a rate it can't afford. Central banks can usually suspend if they want, but if for some reason they do not (Think Thailand, 1997) then they will face a run, whether the money they issue is paper dollars or checking account dollars.

I can’t see why anyone would join a run on a central bank. It wouldn’t make sense for depositors to run to commercial banks because a deposit of $X at a commercial bank is simply a promise by the commercial bank to give the depositor $X of central bank money if the depositor wants it.

Depositors could run to another currency. In Thailand in 1997, the Thai government had incurred a lot of debt denominated in other currencies, and the value of its currency collapsed. So running before that collapse would make sense. But the US government has incurred no such debts: its debts are denominated in US dollars.

Runs make sense where someone is trying to ARTIFICIALLY maintain the value of something (e.g. the pound Sterling in 1992 before the UK crashed out of the ERM). But a currency which FLOATS is just like shares in a bank (as distinct from deposits). Shares are a non-runnable liability.

Ralph:Yes, floating liabilities are run-proof. But if the Thai bank issues 100 baht, and its assets are worth $99, and it tries to maintain convertibility at $1=1 baht, then there will be a run, since the bank will run out of dollars before the 100th baht is redeemed for a dollar

But cental bank deposit accounts could make creditors more likely to run from private institutions - so rather than solving the problem of runs, such accounts could exacerbate runs and make them more likely.

The other problem with central bank accounts is that they need to be invested, and who wants central banks playing a (greater) role in resource allocation? Imagine also the sitation central banks allocating an increasingly large volume of funds in the event that creditors run to it?

I doubt we'll ever abolish cash, if for no other reason than too many people (in particular politicians) benefit from the occasional truly anonymous transaction.

I'd be interested in seeing proposals on how a cashless society works in practice (I haven't really looked into it). How do I give my neighbor half the cost when we replace the fence between our property? How do I pay the babysitter or the kid who mows my lawn? Buy something at a garage sale? Let my kid ride the pony at the grocery store (which is still 1 cent)? Will all vending machines have to be tied to the internet?

How are transaction costs handled? Today there have been scandals when the government moved to non-cash benefits for food stamps, etc. and banks added fees to many / most transaction types. I can see the law to abolish cash subtitled the "guaranteed bank profit act" with it becoming impossible to make a purchase without a bank taking 1-2%.

I also wonder how this will affect teaching kids about money. When I was growing up my parents setup a savings account for me. It was passbook savings, so I could see exactly how much money I had and how much interest I earned in the passbook. I found it much harder to teach my kids about bank accounts in the 90s because they didn't have the passbook. Instead a statement occasionally showed up in the mail showing one or two transactions, much harder to explain.

If we move away from cash I can see a new generation not having a clue about money. They can sometimes buy something, sometimes not, and never really understand what's going on. With cash it's easy to set aside money for the rent or a payment by physically setting the money aside. In a cashless society we've eliminated a whole class of money management techniques which have worked well for a large percentage of the population.

"I'd be interested in seeing proposals on how a cashless society works in practice (I haven't really looked into it). How do I give my neighbor half the cost when we replace the fence between our property? How do I pay the babysitter or the kid who mows my lawn?"

Sweden has already solved this problem with Swish, I.e. see for instance: http://ecommercenews.eu/swedish-banks-want-use-swish-ecommerce/

When settling with friends, etc. I tend to use Swish for non-trivial amounts - it provides instant clearing between bank accounts with no transaction fees and a very quick and easy user experience (you use mobile numbers for identification purposes - no need to memorize account numbers, etc.).

Currently most dollars are created by banks when loans are made. If all dollars were on the books of the Fed, the Fed would have to explicitly create new dollars for lending. This would be a big change in the way the economy works.

The main driver of eliminating cash is the policy decision to go to negative rates. If rates go sharply negative from today's levels, eliminating paper cash will be absolutely necessary to maintain monetary velocity.

I'm trying to figure out why negative rates will stimulate the economy when negative interest rates (reducing the money supply) semm to me to logically imply deflation, which most economists look at with horror.

Then again, without being an economist and without being able to make a good argument for it, I think if the Fed were to bring rates back up to more traditional (3-5% levels) we'd see the economy take off much more than today. I can't give a reason other than that the big economies which have tried near zero interest rates (Japan for years, the US, UK, EU, etc. for a shorter time) all seem to sit in the doldrums.

There'd be no need for the Fed to "explicitly" create dollars for lending purposes. The Fed / government just needs to print and spend enough dollars into the economy to keep it ticking over at full employment / capacity. As to who lends how much to who, that's entirely up to individuals or individual firms.

But what firms would be barred from doing is what banks currently do, namely accepting deposits (i.e. guaranteeing people $X back for every $X they deposit) while lending that money on. That amounts to money creation or "money multiplication".

I.e. where someone wants a bank or bank like entity to lend on their money, they'd have to buy into a mutual fund of their choice run by the bank. That's full reserve banking, as advocated by Milton Friedman, Lawrence Kotlikoff and several others.

Yes, yes. Each of us shall have an account at the Fed tracking our wealth and all of our transactions. This account shall be linked to the microchip embedded in our brain stem at birth. Oh, think of the enumerable efficiencies! A Brave New World indeed.

In theory govt could replace cash. In practice we had a barter economy before cash, and that barter economy would return for those transactions that have value in being cash based. No doubt over time a form of cash would evolve within that barter economy - probably not the salt that used to be used, but some other commodity of reliable value and easy exchange. For all I know it'll be pokemon. The point is that so long as people have a need for cash, cash will exist in one form or another.

I did not do so at school, but after graduation I love to cheat like hell, and glimpse at what others made of it. you should not copy blindly, but it may give you a short cut in thinking. About one century ago in the Netherlands, commercial banks served big business, and did not want petty accounts of shop-keepers and farmers; some cooperative banks were founded, and government was urged to provide some. The Post Offices were used for a very bare online payment service, Bank of Amsterdam type. It could not afford much of debtor control (large numbers of petty amounts), so payment-orders without sufficient balance simply bounced. When I was a student, it served about half of banking traffic; it had fans of the simple solution. Another section of the people favoured the richer service of commercial banks. Big amount transactions in cash were still in use in some kinds of business, and it still was and still is possible to settle without cash or banking money; with or without record, and in cordial traffic that remains necessary, so crime still will be able to abuse it. Once coins and banknotes were very different and now we still have coins and bank notes, but electronic payment is driving it back rapidly. (Before I cannot make the joke anymore: In US-elections some call for "Change"; here they wil not settle for less than bank notes.)

Through history administration has claimed a key role in payment traffic without allowing alternatives. There is a monopoly for public coins, and public bank notes, so there should be a public electronic account network, eventually in commercial bank management; the Crane-idea. The practical outcome may not exterminate rudiments rigorously; metal and paper will turn up now and then.

Just to clarify blockchain/Bitcoin technology a bit, there is currently no mechanism to prune old and unnecessary transaction information from the Bitcoin blockchain. It is constantly growing in size with no upper bound. That is a problem that should probably be solved (as advances in storage and data transmission technology may not always keep pace with blockchain growth), but it is not going to be easy.

The Bitcoin blockchain is validated by the Bitcoin software by cryptographically verifying every block in history that follows from the Genesis Block (hard-coded). If you eliminate that process, you eliminate one of the primary security features of the blockchain.

It's certainly possible for certain clients to only care about a portion of the blockchain that pertains to certain coins. However, they still rely on complete copies of the blockchain existing somewhere else. I think this is a solvable problem, but we're not there quite yet.

Interesting. Thanks. When blockchain dollars start to be used to clear high speed trades that should be fun. I presume US issued blockchain dollars could be retired and reissued from time to time just like current notes and coins, thus wiping out the history. Perhaps the best analogy is that blockchains are like the strings of endorsed checks that circulate sometimes with cash shortages. I write a check to you, you endorse it to Bob, Bob endorses it to Jane and so forth.

Indeed. One of the major debates raging right now in the Bitcoin world is about raising the blocksize limit. Currently, it is set at 1MB, so the Bitcoin blockchain is growing, on average, by no more than 1MB every 10 minutes. However, that severely limits the transaction clearing capacity of the system and even at its current scale, the Bitcoin network is now pressed against that limit.

Non-bitcoin blockchains used by banks and other financial industry players may not have these sorts of issues since they can use different models of trust and they do not face the same challenges as Bitcoin, which operates globally over the public internet.

From my humble perspective, the cash played, plays and will play a central role in our civilization but we need to understand the world without cash as alternative and complementary to the cash. We all need to step back and do our homework on questions such as where, when and how it will be more efficient than the cash.

Though it is true that on-chain BTC transactions would give the FED increased access to the blocksize and actually be a decrease on the fungibility of cash. That is not true about off-chain transactions (LTN), and that is not true about privacy coins like XMR. They have superior fungibility to cash "no memory"

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.

About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!